The last couple of years have been a time of unusual calm in global financial markets. Equities and bonds have generally risen together, continuing their recovery from the crisis that struck in 2007. Such sell-offs as there have been along the way have been short and shallow. To find out if these abnormally placid conditions are likely to continue through 2015, Arabian Knight spoke to Eduardo Martinez Campos, Global Head of Investments at Citi Private Bank. 

“We saw a sudden burst of volatility in October 2014, with stocks selling off and oil plunging,” says Martinez. “But while oil has kept falling, financial markets as a whole quickly steadied themselves after that outbreak of turbulence. The key question now is whether the factors behind that volatility will keep affecting markets this year. We think that they will.”


UNEVEN ECONOMIC GROWTH

The world’s main challenge, according to Martinez, remains that of sluggish economic growth. “While we have seen the US consolidate its recovery, the Eurozone and Japan still face significant obstacles,” he says. “Inflation in both places is running at well below the levels that their central banks desire.” 

Citi Research forecasts that the world economy will grow at 3.1 per cent in 2015, up from 2.7 per cent in 2014. But it also expects that growth to be very uneven across different economies. While the US could grow by three per cent, the Eurozone economy may expand at only 1.1 per cent.

“This uneven pattern of growth is likely to dictate what happens to monetary policy this year,” says Martinez. “The US Federal Reserve (Fed) has already ended its Quantitative Easing asset-purchase programme, and both the Fed and the Bank of England are expected to raise interest rates from their current historic lows.” 


MONETARY POLICIES DIVERGING

“At the same time, the European Central Bank and the Bank of Japan are expected to pursue more aggressive monetary policies in an effort to counteract deflationary forces and stimulate growth in their economies,” he continues. “Unlike in recent years, therefore, monetary policy is going to be heading in different directions in certain countries.”

This expected divergence in monetary policy – as well as very different rates of economic growth – could be a significant influence on markets in 2015. “In recent years, different asset classes like stocks, government bonds and corporate credit have tended to move more closely together than they normally do,” says Martinez. “Going forward, though, we expect asset classes to become less correlated.”


EMERGING MARKETS

The prospect of rising interest rates has already helped the US dollar to strengthen. “We expect the dollar to continue to reverse its long-term weakness and appreciate against most currencies,” comments Martinez. “This represents a challenge for emerging markets, whose borrowing costs have tended to rise during periods of dollar strength.”

Citi Research expects China – the largest emerging market of all and the world’s second biggest economy – to grow by 6.9 per cent in 2015, down from an estimated 7.3 per cent in 2014. “We see China to keep trying to strike a balance between growth and reform in its economy,” says Martinez. “At the same time, the country will also likely take further action to liberalise its capital markets.”

This process of opening up its capital markets has important implications for China’s currency. “Along with the increasing weight of Chinese trade flows, it should bolster the role of the Chinese yuan as a major international currency in the years to come,” he says.

Geopolitical risks could also contribute to market volatility in 2015, in Citi Private Bank’s view. Martinez highlights crude oil, where the revolution in the North American energy industry is seeing output surge. At the same time as this increased oil supply, though, he points to the risk of disruption to oil output from conflicts in the Middle East and Russia, as well as from social unrest elsewhere in the world. 


THEMES FOR A LATE-CYCLE RECOVERY

“Overall, we think that the economic cycle and bull market in risky assets has reached its later stages,” comments Martinez. “However, we don’t think that it is time for investors to switch to a much more defensive stance nor that a recession is imminent. The outlook for global equities is more positive than that for global fixed income for 2015. We anticipate a nine per cent total return on the former and 1.5 per cent on the latter.”

Given its outlook for the economy and for asset classes, Citi Private Bank has identified four key investment themes for its clients in 2015: Seek Alpha over Beta, Exploiting Volatility, Transforming Commerce and Social Investment. Martinez explains the thinking behind them:


SEEK ALPHA OVER BETA

“Over the last five years, the average investor has been heavily invested in cash. One could have beaten such an investor’s portfolio merely by having had the courage to take broad-based exposure to equities and fixed income. But the best-performing assets over the next five years are unlikely to be the same as those that did best in the last five years.

“We are therefore making the case for greater selectivity and more high-quality investments. This involves a strategy of ‘resilience through growth’, with an emphasis on assets that are less sensitive to business-cycle booms and busts. This doesn’t mean a risk-averse portfolio, but ones made up of investments that may be able to preserve themselves against falling markets and also deliver a potentially stronger performance over the next five years. 


EXPLOITING VOLATILITY

“While we remain bullish on the near-term outlook for risky assets like equities and high-yield credit, the unusual calm of the past three years seems like an historical aberration. However, some asset prices suggest investors expect the calm to persist. With merely ‘unlikely events’ priced as ‘extraordinarily improbable,’ it is cheaper to hedge risks. We believe investors should consider preparing their portfolios for a wider range of possibilities in markets and the world economy.


TRANSFORMING COMMERCE

“Rapid change is making itself felt even in some of the most traditionally stable businesses.

“Technology is revolutionising commercial and consumer behaviour, creating both victors and victims in the process. This transformation could significantly affect portfolio returns. It can even impact assets traditionally seen as immune to obsolescence, such as commercial real estate. We have identified five specific areas where we think that meaningful shareholder value could be created in the years ahead: mobile commerce, energy, cars of the future, autonomous mining, and consumer businesses serving the cash-strapped younger generation.


SOCIAL INVESTMENT

“The pursuit of social goals alongside investment objectives is an increasingly important priority for many wealthy investors. And thanks to the ongoing development of social investment over recent years, they no longer have to choose between the returns on their portfolio and benefiting society. Social investment nowadays is capable of delivering financial benefits, potentially improving performance and helping to diversify risks. We consider the main kinds of social investment as well as the types of product that can help to build a balanced social investment portfolio.”